For most people, investing funds is associated with complex financial processes. However, don’t think that only professionals with a lot of experience can get a good profit — it’s easy to learn how to invest your own money beneficially. The main thing is to understand the actions taking place in the system and determine what is better to put aside funds for.
One of the most convenient investment tools are bonds. Not knowing how bonds work, many newcomers are afraid of losing funds and reject the very idea of using them. In fact, everything is quite simple — a bond is a security, which an investor buys, actually lending the issuer money. Let’s take a closer look at this question and find out what is an investment bond!
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How do bonds work?
The history of bonds goes back to the distant past, when the first grain-based bond appeared in Mesopotamia about 2400 BC. The prototype of a modern bond was a promissory note, according to which the debtor was obliged to return the funds on time, while also paying remuneration for the use of borrowed funds.
When you enter the stock market for the first time, it’s easy to get lost among the numerous investment and speculation instruments. What are bonds in the stock market? This can be explained by a simple example – by buying bonds, you lend money to the state or a business for a certain period of time. The issuer, whether a company or a state, undertakes to return the money and pay interest – coupon income – during the entire term of the loan. They are usually charged twice a year.
Coupon income is the same profit that an investor expects when buying bonds. A coupon can be permanent or floating, changing depending on the conditions that are indicated in advance in the issue prospectus.
Such a tool is good because an investor knows when the debt will be returned, as well as the exact terms of issuance — how much will be earned for the entire period until the debt is repaid. That’s why investments in bonds are called fixed-yield investments and are considered conservative.
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Bond features
The bond has a number of typical features:
- Date, or maturity date – shows when the company that issued the bonds will fully repay the amount borrowed from the investor. Maturity dates can vary from one year to 30 years.
- Nominal value — the amount that will be returned to the investor during the repayment of the bond. It can be paid in installments as it approaches the maturity date.
- Coupon or interest — the income paid to the investor. The coupon can be fixed or floating. Usually, interest is paid according to a certain schedule until the maturity date of the security.
The total income from investing in bonds consists of two components: the amount of interest paid (coupon income) and the difference between the purchase price and the repayment price (discount income).
What is a bond in finance?
Bond meaning in finance is huge since this tool plays an important role in the state’s and society’s life. They allow the government to fill the budget, attract foreign currency, and finance targeted state, regional and sectoral programs. The role of bonds is difficult to overestimate. They perform several essential functions:
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- formation of the state debt;
- filling the state budget by attracting free funds from individuals and legal entities;
- regulation of monetary circulation;
- implementation of the monetary policy of the state;
- containment of inflation;
- mobilization of funds for the implementation of targeted economic programs.
When choosing a bond, it is necessary to pay attention to the profitability, liquidity, and creditworthiness of the issuer. A popular passive earning strategy is “Buy and Hold”, which involves the purchase of securities of highly reliable issuers with maximum profitability. Such securities include blue-chip securities (companies with an upward trend) and second-tier securities characterized by moderate liquidity.
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Ways to buy bonds
This security is considered an excellent asset for relatively stable investment. If you decide to buy it, then a competent solution would be to purchase securities through a broker or in a bonds stock market.
The purchase and sale can be carried out online — in the broker’s mobile application or through a terminal installed on a personal computer.
The bond can be sold before its expiration date (in this case, you’ll be able to receive your funds, and the other person will continue to receive coupons). People’s bonds are usually distributed among private investors — agent banks.
How to buy individual bonds
A popular way for investors to buy individual bonds is to go through a broker. Still, depending on a person’s connections, they may also be purchased directly from a government entity issuer.
When you buy individual bonds, you should look into a specific yield that goes across a certain period. Even if the yield is set for 10 years or more, you will have the benefit of a fixed income.
This buying strategy provides more flexibility compared to ETFs and bond mutual funds. This is because the latter can fluctuate over time, leading to losses in your investment.
Buying bond ETFs
One efficient way to invest in bonds is to buy ETFs. A bond ETF may be managed actively or passively, with the prices set at a lower point than a mutual fund. As they are offered at a very low cost, they are often the better option for investors that don’t have a big starting capital.
Given the cost of EFTs, investors can keep more of the capital to themselves. Returns will also be more profitable, as they will no longer have to pay for manager fees (as it is with mutual funds).
Bond EFTs also represent the better option when it comes to liquidity. Unlike mutual funds that trade once a day, EFT shares are traded like regular stocks. This means you can get profit during regular market hours, acting as a steady form of payment.
Buying bond mutual funds
When you buy bond mutual funds, you get the benefits of buying regular (individual) bonds, minus the high risk. The process of handling mutual funds is much simpler, so when applied to bonds, it serves as a bonus.
Bond mutual funds can provide professional management along with diversification. You get the benefit of a regular fixed income while a professional is managing your funds. Plus, when your bonds are in a mutual fund, you are not limited to holding several individual bonds. You can hold hundreds of them, which may lead to more profit.
Last but not least, when you buy bond mutual funds, you can enjoy a tax break as well. This can greatly depend on the life stage and initial tax bracket, which is why case-by-case research is due. For the most part, the interest paid on these bonds may also be exempt from federal income tax.
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